The zero rate trap – The Economist 09-18-15

No Fed tightening was a sensible decision. The Fed is in a trap: low interest rates have raised global equity markets, whose collapse in August helped in preventing the Fed from raising rates.

Most British homeowners have variable rate mortgages so while interest rate cuts staved off a potential disaster in the housing market, the UK housing market did not return to more affordable price levels as it did in the US.

May Rostom at the Bank of England says:

The ratio of house prices to first-time buyer incomes in London is 9.4 versus 2.6 in 1996 and 7.2 at the last peak in London.

The 1971-1980 and 1981-1990 birth cohorts face sharply rising debts to get on the housing ladder but their incomes have not risen near as fast.

Since 1995, the debt of older generations has barely budged, while that of those aged 25-45 has shot up in real terms. A world where younger households reach 65 and still have debt is possible.

The widening wealth inequality across income or socioeconomic categories is also across generations as the low-rate regime has boosted asset prices for the older generations that own the assets.

The Bank of England is in a trap: if it raises interest rates and forces down house prices, young people not yet on the housing ladder would benefit, but for those with high debts, it would be a disaster. Building more houses is not enough: even Savill’s forecast of a 55% rise in homebuilding over a 5-year period would produce only 167,000 units in 2018, versus the 240,000 needed.

Read the full article at http://www.economist.com/blogs/buttonwood/2015/09/asset-markets-and-monetary-policy

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